Volatility in the pound the focus for traders as they eye Brexit deadline

Alexandra Cain

Aug 30, 2019 — 11.00pm

Brexit negotiations and the ebb and flow of sentiment towards the deal have driven trading in the British pound sterling and euro over the past year. But investors' increasing confidence in a soft Brexit landing is now taking a back seat to other market drivers.

The Bank of England's return to more normal monetary policy settings, as well as the pound's relative attractiveness versus the US dollar, is top of mind for foreign exchange traders.

"Traders are expressing their views on Brexit through the pound versus the US dollar cross trade over the past nine months, rather than by trading the pound against the euro," says Greg McKenna, chief market strategist at AxiTrader.

"We've seen volatility in the pound recently, as investors have become more positive towards Brexit. Weak US data and a stronger greenback combined to support the pound."

Joshua Mahoney, an analyst with IG, agrees the primary focus for trading Brexit is the pound.

"The resurgence in the pound has been driven by improving UK data in the face of Brexit uncertainties, with progress on negotiations with the Eurozone also helping drive the upside for the pound over recent months," says Mahoney.

There has been a resurgence in the pound despite ongoing Brexit negotiations. Chris Ratcliffe

"Post-referendum, the euro has been relatively resilient to Brexit issues. The fear of a complete no-deal was certainly a worry for the eurozone, helping drive euro volatility. However, while risks still remain for the euro, the key element over the near-term is whether a transitional deal is completed."

"The ultimate deal is expected to be a constructive conclusion of Brexit, albeit with a lot of noise ahead of it. There is no Europe without the UK's military power. There is probably no Europe without the UK's financial centre role and educational system, either. So, to think that there is a hard Brexit scenario in the sense that the UK will stand on its own and then the rest of the Europe will be either against or in parallel to the UK is an illusion," he says

Seeking 'constructive outcome'

Jakobsen says investors are trading the outcome of the final deal. "The consensus is for a constructive end. The potential deviation is between a more constructive or less constructive outcome."

A less constructive outcome could be another vote on Brexit again, which seems unlikely. Another risk is negotiations may stall, delaying the outcome.

"But those scenarios are outliers from the most likely scenarios, which are that we have a constructive outcome or slightly less constructive outcome. Ultimately, it is a win-win for everyone to get a constructive outcome," says Jakobsen.

The value of the pound has improved over the past 12 months despite the Brexit vote, rising from about 93 pence against the US dollar a year ago to about 40 pence against the US dollar now.

"There are signs the UK economy is slowing down but so is the European economy. So there isn't really a play to be had, given the euro and the pound are interlinked, being small, open economies dependent on exports. Both of them are prisoners of the global economy's growth. So the pound and the euro are more influenced by the economic outlook than Brexit," Jakobsen says, adding that he expects the pound to rise against the US dollar.

"If you were negative on Brexit, and expect a hard ending to the deal, you could sell the pound and buy the Swiss franc, or sell the pound and buy the euro. But I wouldn't be doing that."

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Saxo Bank is bullish about the future of the euro. "We think Europe is well placed in terms of incoming demographic and technology changes. Because Europeans have relatively high average educational levels, automation, artificial intelligence and technology improvement will work in its favour.

"In an environment in which investors are looking to reduce exposures to US dollars, enabled by China's ability and willingness to become a reserve currency, we think money will flow out of the US into Europe as a reservoir of safe haven deposits," says Jakobsen.

Markets 'relaxed' over Europe

Immigration is one of the risks that could destabilise Europe. "There is a risk immigration will resurface as the No. 1 issue facing Europe. This could create a negative nationalistic drive that reduces European economies' ability to evolve," he says.

Michael McCarthy, chief market strategist for CMC Markets, says it appears concerns about Brexit's impact on the British economy were overdone and traders who took that view have done well.

Looking at European currencies more broadly, he is surprised at low trading levels for the Swiss franc against the US dollar.

"The Swiss bank's safe haven status is not as valuable as it once was. But we have seen more activity in the Norwegian krone, which could be related to the volatility we're seeing in energy markets," he says.

McCarthy says it appears markets have taken the view Europe will remain politically sane, despite the rise of nationalism.

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"In broad brush terms, markets are pretty relaxed we won't see extensive political change. That doesn't seem to be priced at the moment."

Turning to the long-term outlook, Jakobsen expects the euro and pound may become potential reservoirs of deposits.

"People are unlikely to go from depositing in US currency to depositing in the Chinese currency. So, in the next 10 years, other currencies that have liquidity will absorb some US dollar flows, which is likely to be negative for the US dollar," he says.

The euro and the pound are likely to benefit from this, helping to maintain the price of these currencies over time.